I'm pretty sure the reason watch phones haven't taken off isn't because they are too large. Don't tell Kempler that though. They have launched its $199 unlocked WPhone, which they claim is the world's smallest watch with an integrated phone.
Very much like the LG GD910, except smaller, it has a touchscreen face. It is a quad-band GSM device so you can throw in your AT&T or T-Mobile SIM for voice. It has 4GB of on board storage and a microSD card slot for your media use.